If investing seems intimidating to you, you’re not alone; investing feels that way to most people. Part of the reason is because of all the jargon and complex terms that are used by financial professionals and the media. Plus, investing is so heavily tied to your lifestyle. It’s no wonder that most people think that investing is too complex. I have some wonderful and exciting news: It’s not, especially when you understand a few simple investing basics.
At it’s simplest form, investing is shopping; it’s buying things with your money that will give you something that you want in return. The problem is that you may be unclear about what you can reasonably expect from your investment shopping. In this article, I am going to show you one of the most important investing basics that will help you measure and even estimate potential investment returns. It will help you get a clearer vision of how to comparison shop among all the many investing options. You’ll also be able to see how to make sure that your purchase holds up and performs as expected.
The valuable tool is called a benchmark, which allows you to know how well your investment is performing compared to other investments of the same type with the same or similar risk. When comparison shopping for anything, you are creating and using your own little benchmark. You may have experienced intimidation when shopping for a diamond. Let’s face it: the color, cut and clarity lingo can be very confusing! Plus, buying the wrong diamond can be an expensive mistake!
When you are shopping for a new diamond ring, for example, you probably have a list of all of the features of the diamonds you are considering so you can compare among the designers or stores. Let’s say that you’ve seen the perfect 2 carat, VS2, H color diamond that’s set in platinum. (Wow!) A valid certification documented these characteristics. The price is $10,000, but you want to shop around making sure that your investment is priced well. That first diamond ring, costing $10,000 at that particular time, with those certain features, is your benchmark. You can use those facts to invest well. This first ring sets the standard, and it’s your benchmark. You’ll use it to price and compare other rings. You can see how valuable this confirmed comparison would be. It allows you to compare apples to apples, which is not always easy with diamonds, given all the variations in the stones.
Here’s the great news: The same, if not even more reliable tool, exists for stocks, bonds and other investments. Why doesn’t every smart shopper (a.k.a. investor) use the benchmarks? It sounds crazy, but most people don’t take the few minutes to understand them. (Remember if you’re an investor, you’re a shopper, because you’re spending your money on something…a LOT of it!)
Let’s look at an example using benchmarks for traditional investments, such as a stock fund you own in your retirement account. In the earlier example, the benchmark was that perfect diamond ring. In this case, the benchmark is a very, very common index fund for the US stock market because it represents either the overall stock market, or a certain area of it that is most similar to your stock fund. You can use this index to shop and compare stock funds, just like you did for the ring, based on set criteria.
You’d expect your stock fund to do at least as well as the overall market since it is the same type of investment with similar risk. Well, a benchmark allows you to make sure that it is! You can see how important this tool is for every investor! More good news: There is a benchmark for every type of investment, including all kinds of stocks, bonds, real estate and commodities, like gold or oil, so you can use them to measure the results for every type of investment.
Now let’s go back to the stock fund in your retirement account and you can see how easy and valuable this simple tool is. If the related benchmark index made 10% over a certain time period, and your fund made 6% over the same time period and had higher fees (and possibly even triggered more taxes), you’d know that you could have done better in the other investment. Most people don’t even know to check this, but you do now. This is one of the most important investing basics that many people overlook!